The Market’s Odd Behavior and What It Means
The markets seem somewhat out of whack. That can mean unusual forces are at work, and these tend to be hard to quantify.
For example, the yield curve – the difference between long- and short-term rates – has been flattening, which should hurt banks. Yet financial stocks have been strong. Over the past week or so they have outperformed tech stocks by about 10 percentage points.
Equally strange is that likely passage of a major tax cut hasn’t driven long-term interest rates higher. In fact, in recent days longer rates have fallen. That’s a virtual repudiation of Economics 101, which teaches that lower taxes in the context of a tight labor market will spur growth and inflation.
To account for unusual market behavior, China and the chaos in Washington always tend to spring to mind these days. But while Chinese stocks have been under pressure, it’s nothing like the end of 2015 and start of 2016, when Chinese stocks and China’s currency were both crashing.
Making Psychological Sense
The tumult in Washington, though, may be starting to have an impact. After all, when you read that special counsel Robert Mueller has issued subpoenas to a major bank that has close relations with both President Trump and with Russians – only to have Trump’s lawyers deny it – it makes for a lot of uncertainty. Taking shelter in the putatively safe banks and taking profits in the stocks where your gains have been greatest might make sense, at least psychologically.
Not all the news suggests rising uncertainty. Despite a massive display of U.S. airpower over the Korean Peninsula, the North Koreans have invited a U.N. official to the country, presumably to talk about talks. That’s a good sign. It’s reflected by flattish to sloppy performance by defense stocks and the range-bound dollar.
The neutral signals now being generated from all of our indicators are likely on target. We are hoping our SPY ETF indicator will improve to a buy. Right now it’s still tilted slightly negative, but it is clearly improving. Of all the indicators we follow, it has the strongest long-term record. It would be nice to get a buy signal in what is seasonally the strongest part of the year.
Multifold Gains
We have completed calculating our indicators’ two-year performance, with all trades backed by time stamps. In a recent update I explained the trading rule that makes the most sense to apply. It involves having three separate “pots” of money to allow for having as many as three trades open at any one time. We have concluded that following our signals to the letter is the best path. We have tried hard to generate more trades by being a little less rigorous, but it didn’t pay off.
By contrast, trades that strictly follow our signals have reaped multifold gains in just two years. We are simplifying the spreadsheet presenting these results and will publish it shortly. And as soon as I have some uninterrupted free time I will devote it to finding indicators for other popular ETFs, such as financials, and techs.
Editor’s Note: Below is a graph of the gross returns of the 3 pots over time from January 1, 2016 through December 5, 2017. Each pot contains ETF option trades based on indicator signals and following the trading system outlined above. Assuming a starting value of $1,000 for each pot, Pot 1 would have ended with more than $24,000, Pot 2 would have ended with more than $1,400, and Pot 3 with about $820. The spreadsheet can be downloaded here.
Stock Talk
Scott Chan
We have added a chart showing the performance of the 3 pots. Please let me know if you have any questions.
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